When Analysts Run Screaming, Stay Away

As we enter earnings season, let's continue our look at strategies to find the best likelihood of earnings surprise, and to avoid the worst. Last week, I looked at some names with the best earnings estimate revision trend during Q4, the idea being that those names had earnings momentum and could print a strong upside to current Street consensus. This week, we will reverse our strategy and screen for the names with the worst revision trend during the quarter. These names are the "dogs of the Dow," so to speak, although of course we are not limiting ourselves to DJIA names. The "dog" moniker does apply, however.

The strategy on the best estimate trends is to buy them, pure and simple. For the worst trend, however, we do not necessarily want to short them. Typically, the plunging estimate is well recognized on the Street, and often baked into the stock, so a short may or may not work. However, these are names you want to avoid on the long side. When an estimate is falling, you are highly unlikely to get outperformance. If you want a portfolio that will beat the benchmark -- any benchmark -- these names are mud.

The table below shows the worst of the worst: stocks whose Q4 estimate has plunged by a third or more during the quarter.Alcoa (AA) already reported, but this is the case that proves the system. Alcoa reported its first quarterly loss ever, confirming the lower trend (in which analysts only got them down to a $0.12 per-share profit). Among names that haven't yet reported, most just look bad. One oddball is Western Digital (WDC), which is down due to the Thai floods that shut down most of the drive industry this fall. That was an outlier event, and Western Digital could make it up in pricing and surprise to the upside. (In contrast, competitor Seagate (STX) has one of the strongest estimate trends at the moment.)

Carnival (CCL) is especially telling, as it looked horrible before the shipwreck this weekend. Considering how the subsidiary Costa is handling the situation, Carnival is likely going to be fighting off massive lawsuits for the next couple years.

Amazon (AMZN) is another that has been dogged through the holiday sales season. Even though online sales were stronger than in-store, they will not be strong enough, causing analysts to cut numbers and the stock to decline since Black Friday.

When analysts start cutting estimates, it pays to take notice -- don't get left holding the bag.